News:

The Book of the Diner is well worth preserving. I only wish it had reached a broader audience when it might have mattered more. That is a testament to the blindness of our culture. If there is a future to look back from, one difficult question historians will have to ask is how we let this happen, when so many saw it coming. This site has certainly aggregated enough information and critical thinking to prove that.[/b]

With Abe picking his new dovish playmate, and Draghi doing his best to jawbone the EUR down without actually saying anything, it is becoming very clear that no matter what level of bullshit histrionics is used by the politicians and bankers in public, the currency wars have begun to gather pace. Japan's more open aggressive policy intervention is the game-changer (and increasingly fascinating how they will talk around it at the upcoming G-20), as if a weaker JPY is an important pillar of the strategy to make this export-oriented economy more competitive again, it brings into the picture something that was missing from earlier interactions among central banks of the advanced economies – competitive depreciation. The last time the world saw a fully fledged currency war was in the early 1930s. Morgan Stanley's Joachim Fels looks at what it was like and what lessons can be drawn for the sequence of events - there are definite winners and losers and a clear first-mover advantage.

Via Morgan Stanley, Back to the 1930s? What Would a Currency War Look Like?What did the currency war of the 1930s look like?The backdrop for the currency war of the 1930s was the Gold Standard and the Great Depression (many economists blame the former for the latter). By fixing the value of the currency to the price of gold, the Gold Standard prevented a country from printing too much money. If it did, people would simply exchange it for gold (or for other currencies pegged to gold). Yet, this rigid ‘rule’ also denied policy-makers any flexibility to deal with shocks to their economies. This was the reason why the UK abandoned this regime, setting off a volatile chain of events:

On September 19, 1931, sterling was taken off the Gold Standard. It was devalued against gold and hence against the ‘gold bloc’ currencies (currencies that remained pegged to gold). The run-up to this event and its fallout was felt throughout the world.

Prior to the devaluation, in June and July 1931, one prominent bank in both Austria and Germany failed, which led to capital controls being imposed in both places. Capital controls protected these economies in the near term, but exacerbated fears about the future of sterling and the Gold Standard itself.

Following the devaluation of sterling, Norway and Sweden went off the Gold Standard on September 29. A day later, Denmark followed.

The US economies, like other countries of the gold bloc, lost competitiveness and exports turned down. Eventually, in January 1934, the US Congress passed the ‘Gold Reserve Act’ to nationalize gold held by banks and monetized it by giving banks gold certificates that they could use as reserves at the Fed. More importantly, it also forced a devaluation of the US dollar against gold.

Like the US economy, the remaining gold bloc countries (France, Germany and some smaller economies) also suffered a loss of competitiveness and poor export and industrial production growth. By 1936, they gave up and abandoned the Gold Standard as well.

What lessons can we draw from the events of the 1930s?We draw three pertinent lessons from that episode:

Lesson 1: As in every crisis, events were and will always be highly non-linear, with domestic conditions the most likely cause: It was painfully high unemployment that was the main driver of the devaluation of sterling.2 Although unemployment had been painfully high for a while, it was only a few months prior to the devaluation that market fear really ratcheted up.

Lesson 2: Markets punish policy uncertainty: Needless to say, there were dramatic movements in the exchange rate of the countries that devalued. However, with the devaluation out of the way, market and economic pressure as well as policy uncertainty shifted to the ‘gold bloc’ economies. For investors, it became a matter of when, rather than whether, the gold bloc economies would be forced to respond.

Lesson 3: Early movers benefited at the expense of the gold bloc, a ‘beggar-thy-neighbor’ outcome: From an economic standpoint, the sharp improvement in competitiveness of the early movers stood them in good stead against the gold bloc economies who stuck to the regime. Exhibit 1 shows that the UK and the Scandinavian economies saw a significant improvement in industrial production by 1935, whereas the ‘gold bloc’ economies (France and Germany – even though the latter employed capital controls) suffered. By the time the gold bloc economies capitulated, they had lost significant ground on this front to the early movers.

Could it happen again? Like any historical precedent, there are differences and similarities that must be accounted for.What’s different this time? Unlike the Gold Standard era, most major currencies are now part of a flexible exchange rate regime, which should make such large currency moves less likely. Further, extreme tail risks that might well have precipitated such dramatic policy responses only a few years ago have also receded.What’s similar? Domestic origins and ‘beggar-thy-neighbor’ effects: Even though policy-makers battled using exchange rates, the events of the 1930s had their origins in domestic issues. As mentioned above, it was painfully high unemployment in England that led sterling off the Gold Standard. The competitive devaluations that followed were also reactions by policy-makers to protect their domestic economies.Similarly, it is the domestic agenda that could drive competitive depreciation today. In this vein, the desire of Japan’s policy-makers to revive investment in their export-oriented economy likely means that the yen will likely play an important role. However, since global demand is likely to remain sluggish, a revival of Japan’s export sector on the back of yen weakness is likely to eat into the market share of other exporters – something that could well invite measures to curb significant weakening of the yen. These negative spillovers are identical in nature to the ‘beggar-thy-neighbour’ policies of the 1930s.If it did happen, what could an improbable but not implausible sequence of events look like? In what follows, we create a plausible sequence using events that have both a reasonable probability of occurring and are already on investors’ radar screens:

The starting point: Japan’s policy-makers initially follow a concerted plan of reflating the Japanese economy, with a weak yen as an important pillar of strengthening the export sector.

Further easing from the major central banks... The ECB and/or the Fed ease further due to a deterioration in financial conditions. In the case of the euro area, euro strength or an idiosyncratic increase in risks might be responsible for a tightening in financial conditions. In the US, the obvious candidate is the risk surrounding the fiscal cliff and the debt ceiling confronting the US Congress.

...and/or capital controls from EM economies: Uncomfortable with the combination of further capital inflows and yen weakness, some AXJ and LatAm economies impose capital controls.

Japanese policy-makers react to yen strength: In order to ensure export competitiveness, Japanese policy-makers take further measures to weaken the yen.

There isn’t much in the ‘timeline’ above that is news, yet the combination serves well to illustrate how a currency war could plausibly play out.Where are we now?The key variable in the sequence of events above is the reaction of Japan’s policy-makers. If a weaker yen is indeed an integral part of their plans and if they have a strong intent to make sure it remains so, the risk of a currency war is higher now than it has been in the past. Investors have moved beyond questioning whether EM economies will have a response and are now wondering at what point such a response is likely. At the same time, near-term risks in the US and euro area economies remain in play, as does the prospect of prolonged or even enhanced monetary stimulus.In the EM world, Japan’s export competitors in AXJ could respond with some combination of verbal intervention, FX intervention, capital controls and, with a much lower likelihood, policy rate cuts. In the particularly interesting cases of Korea and Taiwan, our economist Sharon Lam believes that verbal intervention (already under way to some extent), intervention in the foreign exchange markets and capital controls represent the most likely policy reactions. Rate cuts at a time when both economies are already expanding may serve to accelerate domestic growth and perversely cause even more capital inflows and currency appreciation rather than depreciation. For moderate moves in the yen’s value, the effects on China are likely to be limited since it does not compete head-to-head with Japan’s high-end electronics and car exports. However, in a currency war situation, the slow-moving USDCNY exchange rate may make restoring competitiveness tricky.However, even as we discuss AXJ, let us not forget that other parts of the EM world are also concerned about currency appreciation. For all the talk about potential policy action in AXJ, we have already seen some of it come out of Latin America. In contrast to AXJ, Latin America is slowing, which puts rate cuts firmly on the agenda. Indeed, Colombia’s recent rate cut was likely influenced by the peso’s strength. Luis Arcentales, our Mexico economist, believes that concerns about the currency war have also probably been an influencing factor in Banxico’s u-turn towards a dovish stance from a hawkish one just a few weeks ago. In an innovative twist to the usual FX intervention, Peru has announced that it will buy back its international bonds and issue ones denominated in its domestic currency instead. Even Chile, one of the most advanced and stable EM economies, is discussing structural reforms to address the strength of its currency.In summary, while a currency war is not our base case, the new-found commitment of Japan’s policy-makers does raise the risk of retaliatory action to keep the yen weak, and brings us a step closer to a currency war. The experience of the 1930s suggests to us that such large currency crises are likely triggered by domestic issues, and that they do create distinct winners and losers. EM policy-makers are already gearing up to make sure they remain on the winning side, but the balance of power for now rests with Japan.Lessons From The 1930s Currency Wars

As the winter storm pounded the Northeastern United States today, gasoline futures hit another high. The March delivery contract broke $3.06, indicating that retail prices for fuel will be going up.

Already prices at the pump are the highest for this time of year.

CNBC: - Nationally, retail gasoline prices have soared 11 cents in a week and nearly 30 cents in a month to $3.57 a gallon on Friday, according to AAA. Pump prices are the highest on record for early February, and are rising the fastest along the coasts.

The state-wide average price of gasoline in New York is $3.92 a gallon and California gas prices on average have now surpassed the $4-a-gallon mark.

Increased demand from abroad, stronger crude prices, and some refinery shutdowns are all contributing to higher prices.

I love the part about along the lines that "money will either disappear or become worthless". I've been trying to figure out a way to simplify explaining deflation vs. hyperinflation and how the end result is basically the same. For the more economically sophisticated I've been saying that computer digits will revert to their intrinsic value, but that goes over most people's heads.

A fairly long screed by Erik Townshend and nothing real new for veteran Diners, but a good primer for newbies on how the IMS works (or doesn't).

The main thing which bugs me about this is that the flight to a "safer" currency is unexplainable. If nations could trade directly in Gold, they would have done so long ago and abandoned the Dollar when Nixon shut the Gold Window. Who would believe Chinese Yuan have any more value than Dollars?

When the Dollar rolls over, Money on the International level of trade is DONE for quite some time, if not (hopefully) forever more.

Commentary: Why Peak Oil Threatens the International Monetary System(Note: Commentaries do not necessarily represent the position of ASPO-USA. )By Erik TownsendIntroductionHaving spent the last several years of my life engineering investment strategies to profit from the inevitability of Peak Oil, I’ve become obsessed with understanding the ramifications of radically different energy supply dynamics on the global economy. There are many facets to this, some obvious and some not so obvious. So when ASPO-USA Executive Director Jan Mueller approached me at the end of this year’s conference in Austin and asked for an article discussing the less obvious economic impacts of Peak Oil, I knew instantly that the topic should be the threat Peak Oil poses to the International Monetary System (IMS). This connection is critically important, but far from obvious.I assure you that this story is very much about Peak Oil, but please bear with me, as I’ll need to start by reviewing what the IMS is and how it came about in the first place. Then I’ll explain the role energy has already played in shaping the present-day IMS, and finally, I’ll tie this back to Peak Oil by explaining why rising energy prices could very well be the catalyst that will cause the present system to fail.

What is the International Monetary System?At the end of World War II, many countries were literally lying in ruin, and needed to be rebuilt. It was clear that international trade would be very important going forward, but how would it work? World leaders recognized the need to architect a new monetary system that would facilitate international trade and allow the world to rebuild itself following the most devastating war in world history.A global currency was out of the question because the many countries of the world valued their sovereignty, and wanted to continue to issue their own domestic currencies. In order for international trade to flourish, a system was needed to allow trade between dozens of different nations, each with its own currency.

A convention was organized by the United Nations for the purpose of bringing world leaders together to architect this new International Monetary System. The meetings were held in July, 1944 at the Mt. Washington Hotel in Bretton Woods, New Hampshire, and were attended by 730 delegates representing all 44 allied nations. The official name for the event was the United Nations Monetary and Financial Conference, but it would forever be remembered as The Bretton Woods Conference.To this day, the system designed in those meetings remains the basis for all international trade, and is known as the Bretton Woods System. The system has evolved quite a bit since its inception, but its core principles remain the basis for all international trade. I’m going to focus this article on the parts of the system which I believe are now at risk of radical change, with Peak Oil the most likely catalyst to bring about that change. Readers seeking a deeper understanding of the system itself should refer to the Further Reading section at the end of this article.

Why is an International Monetary System needed?It simply wouldn’t be practical for all countries to sell their export products to other countries in their own currencies. If one had to pay for wine from France in French Francs (there was no Euro currency in 1944), and then pay to import a BMW automobile in German Marks, then pay for copper produced in Chile in Pesos, each country would face an overwhelming burden just maintaining reserve deposits of all the various world currencies. The system of trade would be very inefficient. For centuries, this problem has been solved by using a single standard currency for all international trade.Because a standard-currency system dictates that each nation’s central bank will need to maintain a reserve supply of the standard currency in order to facilitate international trade, the standard currency is known as the reserve currency. At various times in history, the Greek Drachma, the Roman Denari, and the Islamic Dinar have served as de-facto reserve currencies. Prior to World War II, the English Pound Sterling was the international reserve currency.Throughout history, reserve currencies came into and out of use through happenstance. The Bretton Woods conference marked the first time that a global reserve currency was established by formal treaty between cooperating nations. The currency chosen was, of course, the U.S. Dollar.How does the IMS work?The core of the system was the U.S. Dollar serving as the standard currency for international trade. To assure other nations of the dollar’s value, the U.S. Treasury would guarantee that other nations could convert their U.S. dollars into gold bullion at a fixed exchange rate of $35/oz. Other nations would then “peg” their currencies to the U.S. dollar at a fixed rate of exchange. Each nation’s central bank would be responsible for “defending” the official exchange rate to the U.S. dollar by offering to buy or sell any amount of currency bid or offered at that price. This meant each nation would need to keep a healthy reserve of U.S. dollars on hand to service the needs of domestic businesses wishing to convert money between the local currency and the U.S. dollar.

By design, the effect of the system was that each national currency was indirectly redeemable for gold. This was true because each nation’s central bank guaranteed convertibility of its own currency to U.S. dollars at some fixed rate of exchange, and the U.S. Treasury guaranteed convertibility of U.S. dollars to gold at a fixed rate of $35/oz. So long as all of the governments involved kept their promises, each nation’s domestic currency would be as good as gold, because it was ultimately convertible to gold. United States President Richard Nixon would break the most central promise of the entire system (U.S. dollar convertibility for gold) on August 15, 1971. I’ll come back to that event later in this article.

Triffin’s DilemmaIn 1959, three years after M. King Hubbert’s now-famous Peak Oil predictions, economist Robert Triffin would make equally prescient predictions about the sustainability of the “new” IMS, which was then only 15 years old. Sadly, Triffin’s predictions, like Hubbert’s, would be ignored by the mainstream.The whole reason for choosing the U.S. dollar as the global reserve currency was that without a doubt, the U.S.was the world’s strongest credit in 1944. To assure confidence in the system, the strongest, most creditworthy currency on earth was chosen to serve as the standard unit of account for global trade. To eliminate any question about the value of the dollar, the system was designed so that any international holder of U.S. dollars could convert those dollars to gold bullion at a pre-determined fixed rate of exchange. Dollars were literally as good as gold.Making the USD the world’s reserve currency created an enormous international demand for more dollars to meet each nation’s need to hold a reserve of dollars. The USA was happy to oblige by printing up more greenbacks. This provided sufficient dollars for other nations to hold as foreign exchange reserves, while at the same time allowing the U.S.to spend beyond its means without facing the same repercussions that would occur were it not the world’s reserve currency issuer.Triffin observed that if you choose a currency because it’s a strong credit, and then give the issuing nation a financial incentive to borrow and print money recklessly without penalty, eventually that currency won’t be the strongest credit any more! This paradox came to be known as Triffin’s Dilemma.Specifically, Triffin predicted that as issuer of the international reserve currency, the USA would be prone to over consumption, over-indebtedness, and tend toward military adventurism. Unfortunately, the U.S. Government would prove Triffin right on all three counts.Triffin correctly predicted that the USA would eventually be forced off the gold standard. The international demand for U.S. dollars would allow the USA to create more dollars than it otherwise could have without bringing on domestic inflation. When a country creates too much of its own currency and that money stays in the country, supply-demand dynamics kick in and too much money chasing too few goods and services results in higher prices. But when a country can export its currency to other nations who have an artificial need to hold large amounts of that currency in reserve, the issuing country can create far more money than it otherwise could have, without causing a tidal wave of domestic inflation.Nixon proves Triffin rightBy 1970, the U.S.had drastically over-spent on the Vietnam War, and the number of dollars in circulation far outnumbered the amount of gold actually backing them. Other nations recognized that there wasn’t enough gold in Fort Knox for the U.S.to back all the dollars in circulation, and wisely began to exchange their excess USDs for gold. Before long, something akin to a run on the bullion bank had begun, and it became clear that the USA could not honor the $35 conversion price indefinitely.On August 15, 1971, President Nixon did exactly what Triffin predicted more than a decade earlier: he declared force majeure, and defaulted unilaterally on theUSA’s promise to honor gold conversion at $35/oz, as prescribed by the Bretton Woods accord.Of course Nixon was not about to admit that the reason this was happening was that the U.S. Government had abused its status as reserve currency issuer and recklessly spent beyond its means. Instead, he blamed “speculators”, and announced that the United Stateswould suspend temporarily the convertibility of the Dollar into gold. Forty-two years later, the word temporarily has taken on new meaning.

Exorbitant PrivilegeWith the whole world conducting international trade in U.S. dollars, nations with large export markets wound up with a big pile of U.S. dollars (payments for the goods they exported). The most obvious course of action for the foreign companies who received all those dollars as payment for their exported products would be to exchange the dollars on the international market, converting them into their own domestic currencies. What may not be obvious at first glance is that there would be catastrophic unintended consequences if they actually did that.If all the manufacturing companies in Japan or China converted their dollar revenues back into local currency, the act of selling dollars and buying their domestic currencies would cause their own currencies to appreciate markedly against the dollar. The same holds true for oil exporting countries. If they converted all their dollar revenues back into their own currencies, doing so would make their currencies more expensive against the dollar. That would make their exports less attractive because, being priced in dollars, they would fetch lower and lower prices after being converted back into the exporting nation’s domestic currency.The solution for the exporting nations was for their central banks to allow commercial exporters to convert their dollars for newly issued domestic currency. The central banks of exporting nations would wind up with a huge surplus of U.S. dollars they needed to invest somewhere without converting them to another currency. The obvious place to invest them was into U.S. Government Bonds.This is the mechanism through which the reserve currencystatus of the dollar creates artificial demand for U.S. dollar-denominated treasury debt. That artificial demand allows the United States government to borrow money from foreigners in its own currency, something most nations cannot do at all. What’s more, this artificial demand for U.S. Treasury debt allows the USA to borrow and spend far more borrowed foreign money than it would otherwise be able to, were it not the world’s reserve currency issuer. The reason is that, if not for the artificial need to hold dollar reserves, foreign lenders would be much less inclined to purchase U.S. debt, and would therefore demand much higher interest rates. Similarly, the more that international trade has grown as a result of globalization, the more the United States’ exorbitant privilege has grown.Have you ever wondered why China, Japan, and the oil exporting nations have such enormous U.S. Treasury bond holdings, despite the fact that they hardly pay any interest these days? The reason is definitely not because those nations think 1.6% interest on a 10-year unsecured loan to a nation known to have a reckless spending habit is a good investment. It’s because they have little other choice. The more their own economies rely on exports priced in dollars, the more they need to keep their own currencies attractively priced relative to the U.S. dollar in order for their exports to remain competitive on the international market. To achieve that outcome, they must hold large reserves denominated in U.S. dollars. That’s why China and Japan – major export economies – are the biggest foreign holders of U.S. debt.The net effect of this system is that the USA gets to borrow money from foreigners at artificially low interest rates. Moreover, the USA can become over-indebted without the usual consequences of increasing borrowing cost and declining creditworthiness. Other nations have little choice but to maintain a large reserve supply of dollars as the international trade currency. But the U.S. has no need to maintain large reserves of other nations’ currencies, because those currencies are not used in international trade.By the mid-1960s, this phenomenon became known as exorbitant privilege: That phrase refers to the ability of the USA to go into debt virtually for free, denominated in its own currency, when no other nation enjoys such a privilege. The phrase exorbitant privilege is often attributed to French President Charles de Gaulle, although it was actually his finance minister, Valery Giscard d’Estaing, who coined the phrase.What’s important to understand here is that the whole reason the U.S. can get away with running trillion-dollar budget deficits without the bond market revolting (a la Greece) is because of exorbitant privilege. And that privilege is a direct consequence of the U.S. dollar serving as the world’s reserve currency. If international trade were not conducted in dollars, exporting nations (both manufacturers and oil exporters) would no longer need to hold large reserves of U.S. dollars.Put another way, when the U.S. dollar loses its reserve currency status, the U.S.will lose its exorbitant privilege of spending beyond its means on easy credit. The U.S. Treasury bond market will most likely crash, and borrowing costs will skyrocket. Those increased borrowing costs will further exacerbate the fiscal deficit. Can you say self-reinforcing vicious cycle?

But wait… Wasn’t Gold convertibility the whole basis of the system?If the whole point of the Bretton Woods system was to guarantee that all the currencies of the world were “as good as gold” because they were convertible to U.S. dollars, which in turn were promised to be convertible into gold… And then President Nixon broke that promise in 1971… Wouldn’t that suggest that the whole system should have blown up in reaction to Nixon slamming the gold window shut in August of ’71?Actually, it almost did. But miraculously, the system has held together for the last 42 years, despite the fact that the most fundamental promise upon which the system was based no longer holds true. To be sure, the Arabs were not happy about Nixon’s action, and they complained loudly at the time, rhetorically asking why they should continue to accept dollars for their oil, if those dollars were not backed by anything, and might just become worthless paper. After all, if U.S. dollars were no longer convertible into gold, what value did they really have to foreigners? The slamming of the gold window by President Nixon in 1971 was not the only cause of the Arab oil embargo, but it was certainly a major influence.

What’s holding the IMS together?Why didn’t the rest of the world abandon the dollar as the global reserve currency in reaction to the USA unilaterally reneging on gold convertibility in 1971? In my opinion, the best answer is simply “Because there was no clear alternative”. And to be sure, the unmatched power of the U.S.military had a lot to do with eliminating what might otherwise have been attractive alternatives for other nations.U.S. diplomats made it clear to Arab leaders that they wanted the Arabs to continue pricing their oil in dollars. Not just for U.S.customers, but for the entire world. Indeed, U.S. leaders at the time understood all too well just how much benefit the USA derives from exorbitant privilege, and they weren’t about to give it up.After a few years of tense negotiations including the infamous oil embargo, the so-called petro-dollar business cycle was born. The Arabs would only accept dollars for their oil, and they would re-invest most of their profits in U.S. Treasury debt. In exchange for this concession, they would come under the protectorate of the U.S. military. Some might even go so far as to say that the U.S. government used the infamous Mafia tactic of making the Arabs an “offer they couldn’t refuse” – forcing oil producing nations to make financial concessions in exchange for “protection”.With the Arabs now strongly incented to continue pricing the world’s most important commodity in U.S. dollars, the Bretton Woods system lived on. No longer constrained by the threat of a run on its bullion reserves, the U.S. kicked its already-entrenched practice of borrowing and spending beyond its means into high gear. For the past 42 years, the entire world has continued to conduct virtually all international trade in Dollars. This has forced China,Japan, and the oil exporting nations to buy and hold an enormous amount of U.S. Treasury debt. Exorbitant privilege is the key economic factor that allows the U.S.to run trillion dollar fiscal deficits without crashing the Treasury bond market. So far.

There’s a limit to how long this can lastBut how long can this continue? The U.S.debt-to-GDP ratio now exceeds 100%, and the U.S.has literally doubled its national debt in the last 6 years alone. It stands to reason that eventually, other nations will lose faith in the dollar and start conducting business in some other currency. In fact, that’s already started to happen, and it’s perhaps the most important, under-reported economic news story in all of history.Some examples…China and Brazil are now conducting international trade in their own currencies, as are Russia and China. Turkey and Iran are trading oil for gold, bypassing the dollar as a reserve currency. In that case,U.S.sanctions are a big part of the reason Iran can’t sell its oil in dollars. But I wonder if President Obama considered the undermining effect on exorbitant privilege when he imposed those sanctions. I fear that the present U.S. government doesn’t understand the importance of the dollar’s reserve currency role nearly as well as our leaders did in the 1970s.

The Biggest Risk We Face is a U.S. Bond and Currency CrisisTo be sure, Peak Oil in general represents a monumental risk to humanity because it’s literally impossible to feed all 7+ billion people on the planet without abundant energy to run our farming equipment and distribution infrastructure. But the risks stemming directly from declining energy production are not the most imposing, in my view.Decline rates will be gradual at first, and it will be possible, even if unpopular, to curtail unnecessary energy consumption and give priority to life-sustaining uses for the available supply of liquid fuels. In my opinion, the greatest risks posed by Peak Oil are the consequential risks. These include resource wars between nations, hoarding of scarce resources, and so forth. Chief among these consequential risks is the possibility that the Peak Oil energy crisis will be the catalyst to cause a global financial system meltdown. In my opinion, the USA losing its reserve currency status is likely to be at the heart of such a meltdown.A good rule of thumb is that if something is unsustainable and cannot continue forever, it will not continue forever. The present incarnation of the IMS, which affords the United States the exorbitant privilege of borrowing a seemingly limitless amount of its own currency from foreigners in order to finance its reckless habit of spending beyond its means with trillion-dollar fiscal deficits, is a perfect example of an unsustainable system that cannot continue forever.But the bigger the ship, the longer it takes to change course. The IMS is the biggest financial ship in the sea, and miraculously, it has remained afloat for 42 years after the most fundamental justification for its existence (dollar-gold convertibility) was eliminated. How long do we have before the inevitable happens, and what will be the catalyst(s) to bring about fundamental change? Those are the key questions.In my opinion, the greatest risk to global economic stability is a sovereign debt crisis destroying the value of the world’s reserve currency. In other words, a crash of the U.S. Treasury Bond market. I believe that the loss of reserve currency status is the most likely catalyst to bring about such a crisis.The fact that the United States’ borrowing and spending habits are unsustainable has been a topic of public discussion for decades. Older readers will recall billionaire Ross Perot exclaiming in his deep Texas accent, “A national debt of five trillion dollarsis simply not sustainable!” during his 1992 Presidential campaign. Mr. Perot was right when he said that 20 years ago, but the national debt has since more than tripled. The big crisis has yet to occur. How is this possible? I believe the answer is that because the U.S. dollar is the world’s reserve currency and is perceived by institutional investors around the globe to be the world’s safest currency, it enjoys a certain degree of immunity derived from widespread complacency.But that immunity cannot last forever. The loss of reserve currency status will be the forcing function that begins a self-reinforcing vicious cycle that brings about a U.S. bond and currency crisis.While many analysts have opined that the USA cannot go on borrowing and spending forever, relatively few have made the connection to loss of reserve currency status as the forcing function to bring about a crisis.We’re already seeing small leaks in the ship’s hull. China openly promoting the idea that the yuan should be asserted as an alternative global reserve currency would have been unthinkable a decade ago, but is happening today. Major international trade deals (such as China and Brazil) not being denominated in U.S. dollars would have been unthinkable a decade ago, but are happening today.So we’re already seeing signs that the dollar’s exclusive claim on reserve currency status will be challenged. Remember, when the dollar loses reserve currency status, the U.S.loses exorbitant privilege. The deficit spending party will be over, and interest rates will explode to the upside. But to predict that this will happen right now simply because the system is unsustainable would be unwise. After all, by one important measure the system stopped making sense 42 years ago, but has somehow persisted nonetheless. The key question becomes, what will be the catalyst or proximal trigger that causes the USD to lose reserve currency status, igniting a U.S. Treasury Bond crisis?Elevated RiskIt’s critical to understand that the USA is presently in a very precarious fiscal situation. The national debt has more than doubled in the last 10 years, but so far, there don’t seem to have been any horrific consequences. Could it be that all this talk about the national debt isn’t such a big deal after all?The critical point to understand is that while the national debt has more than doubled, the U.S. Government’s cost of borrowing hasn’t increased at all. The reason is that interest rates are less than half what they were 10 years ago. Half the interest on twice as much principal equals the same monthly payment, so to speak. This is exactly the same trap that subprime mortgage borrowers fell into. First, money is borrowed at an artificially low interest rate. But eventually, the interest rate increases, and the cost of borrowing skyrockets. The USA is already running an unprecedented and unsustainable $1 trillion+ annual budget deficit. All it would take to double the already unsustainable deficit is for interest rates to rise to their historical norms.This all comes back to exorbitant privilege. The only reason interest rates are so low is that the Federal Reserve is intentionally suppressing them to unprecedented low levels in an attempt to combat deflation and resuscitate the economy. The only reason the Fed has the ability to do this is that foreign lenders have an artificial need to hold dollar reserves because the USD is the global reserve currency. They would never accept such low interest rates otherwise. Loss of reserve currency status means loss of exorbitant privilege, and that in turn means the Fed would lose control of interest rates. The Fed might respond by printing even more dollars out of thin air to buy treasury bonds, but in absence of reserve currency status, doing that would cause a collapse of the dollar’s value against other currencies, making all the imported goods we now depend on unaffordable.In summary, the U.S. Government has repeated the exact same mistake that got all those subprime mortgage borrowers into so much trouble. They are borrowing more money than they can afford to pay back, depending solely on “teaser rates” that won’t last. The U.S. Government’s average maturity of outstanding treasury debt is now barely more than 5 years. This is analogous to cash-out refinancing a 30-year fixed mortgage, replacing it with a much higher principal balance in a 3-year ARM that offers an initial teaser rate. At first, you get to borrow way more money for the same monthly payment. But eventually the rate is adjusted, and the borrower is unable to make the higher payments.The Janszen ScenarioWhen it comes to evaluating the risk of a U.S. sovereign debt and currency crisis, most mainstream economists dismiss the possibility out of hand, citing the brilliant wisdom that “the authorities would never let such a thing happen”. These are the same people who were steadfastly convinced that housing prices would never crash in the United States because they never had before, and that Peak Oil is a myth because the shale gas boom solves everything (provided you don’t actually do the math).At the opposite extreme are the bloggers on the Internet whom I refer to as the Hyperinflation Doom Squad. Their narrative generally goes something like this: Suddenly, when you least expect it, foreigners will wise up and realize that the U.S. national debt cannot be repaid in real terms, and then there will be a panic that results in a crash of the U.S. Treasury market, hyperinflation of the U.S. dollar, and declaration of martial law. This group almost always cites the hyperinflations of Zimbabwe and Argentina as “proof” of what’s going to happen in the USA any day now, but never so much as acknowledges the profound differences in circumstances between the USA and those countries. These folks deserve a little credit for having the right basic idea, but their analysis of what could actually happen simply isn’t credible when examined in detail.Little-known economist Eric Janszen stands out as an exception. Janszen is the only credible macroeconomic analyst I’m aware of who realistically acknowledges just how real and serious the threat of a U.S.sovereign debt crisis truly is. But his analysis of that risk is based on credible, level-headed thinking complemented by solid references to legitimate economic theory such as Triffin’s Dilemma. Unlike the Doom Squad, Janszen does not rely on specious comparisons of the USA to small, systemically insignificant countries whose past financial crises have little in common with the situation the USA faces. Instead, Janszen offers refreshingly sound, well constructed arguments. Many of the concepts discussed in this article reflect Janszen’s work.Janszen also happens to be the same guy who coined the phrase Peak Cheap Oil back in 2006, drawing an important distinction between the geological phenomenon of Hubbert’s Peak and the economic phenomenon which begins well before the actual peak, due to increasing marginal cost of production resulting from ever-increasing extraction technology complexity.

“But there’s no sign of inflation…” (Hint: It’s coming)Janszen has put quite a bit of work into modeling what a U.S.bond and currency crisis would look like. He initially called this KaPoom Theory, because history shows that brief periods of marked deflation (the ‘Ka’) usually precede epic inflations (the ‘Poom’). He recently renamed this body of work The Janszen Scenario. Briefly summarized, Janszen’s view is that the U.S. has reached the point where excessive borrowing and fiscal irresponsibility will eventually cause a catastrophic currency and bond crisis. He believes that all that’s needed at this point is a proximal trigger, or catalyst, to bring about such an outcome. He thinks there are several potential triggers that could bring such a crisis about, and chief among the possibilities is the next Peak Cheap Oil price spike.

How Peak Oil could cause a Bond and Currency CrisisThere are several ways that an oil price spike could trigger a U.S.bond and currency crisis. Energy is an input cost to almost everything else in the economy, so higher oil prices are very inflationary. The Fed would be hard pressed to continue denying the adverse consequences of quantitative easing in a high inflation environment, and that alone could be the spark that leads to higher treasury yields. The resulting higher cost of borrowing to finance the national debt and fiscal deficit would be devastating to the United States.A self-reinforcing vicious cycle could easily begin in reaction to oil price-induced inflation alone. But we must also consider how an oil price shock could lead to loss of USD reserve currency status, and therefore, loss of U.S.exorbitant privilege. In the 1970s, the USA represented 80% of the global oil market. Today we represent 20%, and demand growth is projected to come primarily from emerging economies. In other words, the rationale for oil producers to keep pricing their product in dollars has seriously deteriorated since the ‘70s. The more the global price of oil goes up, the more the U.S. will source oil from Canadian tar sands and other non-OPEC sources. That means less and less incentive for the OPEC nations to continue pricing their oil in dollars for all their non-U.S. customers.Iran and Turkey have already begun transacting oil sales in gold rather than dollars. What if the other oil exporting nations wake up one morning and conclude “Hey, why are we selling our oil for dollars that might some day not be worth anything more than the paper they’re printed on?” Oil represents a huge percentage of international trade, so if oil stopped trading in dollars, that alone would be reason for most nations to reduce the very large dollar reserves they now hold. They would start selling their U.S. treasury bonds, and that could start the vicious cycle of higher interest rates and exploding borrowing costs for the U.S. Government. The precise details are hard to predict. The point is, the system is already precarious and vulnerable, and an oil price shock could easily detonate the time bomb that’s already been ticking away for more than two decades.

What if U.S. Energy Independence claims were true?There’s another angle here. Peak Oil just might be the catalyst to cause the loss of U.S. exorbitant privilege, even without an oil price shock.Astute students of Peak Oil already know better than to believe the recently-popularized political rhetoric claiming that the USA will soon achieve energy independence, thanks to the shale oil and gas boom. To be sure, the Bakken, Eagle Ford, and various other U.S. oil and gas plays are a big deal. The most optimistic forecasts I’ve seen show these plays collectively ramping up to as much as 4.8 million barrels per day of production, which is equivalent to about ½ of Saudi Arabia’s current production.

But the infamous “wedge of hope” chart from the EIA projects production declines from existing global resources of 60 million barrels per day by 2030. By the most optimistic projections, all the exciting new plays in the U.S. will replace less than 5 million barrels per day. Where the other 55 million barrels per day will come from remains a mystery! And of course the politicians never bother to mention such minor details when they make predictions of energy independence.But let’s just pretend for a moment that hyperbole is reality, and that the USA will achieve energy-independence in just a few years’ time. Now consider the consequences to the IMS. The oil-exporting nations would lose the USA as their primary export customer, and would no longer have an incentive to price their oil in dollars, or to maintain large dollar reserves. They would start selling off their U.S. treasury bonds, and pricing their oil in something other than dollars. Large oil importers like China and Japan would stop paying for oil in dollars, and would no longer need to maintain present levels of U.S. dollar reserves. So they too would start selling U.S. treasury bonds, pushing up U.S. interest rates in the process. Once again, we have the ingredients for a self-reinforcing vicious cycle of increasing U.S. interest rates causing U.S. Government borrowing costs to skyrocket.Without the artificial demand for treasury debt created by exorbitant privilege, the U.S. would be unable to finance its federal budget deficit. The Federal Reserve might respond with even more money printing to monetize all the government’s borrowing needs, but without the international demand that results from the dollar’s reserve currency status, the dollar would crash in value relative to other currencies as a result of excessive monetization by the Fed. The resulting loss of principal value would cause even more international holders of U.S. Treasury debt to panic and sell their holdings. Once again, a self-reinforcing vicious cycle would develop, with consequences for the United States so catastrophic that the 2008 event would pale in contrast.

Rambo to the Rescue?Let’s not forget that the USA enjoys virtually unchallenged global military hegemony. China is working hard to build out its “blue water navy”, including strategic ballistic missile nuclear submarine capability. But the USA is still top dog on the global power stage, and if the USA was willing to use its nuclear weapons, it could easily defeat any country on earth, except perhaps China and Russia.While the use of nuclear weapons in an offensive capacity might seem unthinkable today, the USA has yet to endure significant economic hardship. $15/gallon gasoline from the next Peak Cheap Oil price shock coupled with 15% treasury yields and a government operating in crisis mode just to hold off systemic financial collapse in the face of rampant inflation would change the mood considerably.All the USA has to do in order to secure an unlimited supply of $50/bbl imported oil is to threaten to nuke any country refusing to sell oil to the U.S. for that price. Unthinkable today, but in times of national crisis, morals are often the first thing to be forgotten. We like to tell ourselves that we would never allow economic hardship to cause us to lose our morals. But just look at the YouTube videos of riots at Wal-Mart over nothing more than contention over a limited supply of boxer shorts marked down 20% for Black Friday. What we’ll do in a true crisis that threatens our very way of life is anyone’s guess.If faced with the choice between a Soviet-style economic collapse and abusing its military power, the USA just might resort to tactics previously thought unimaginable. Exactly what those tactics might be and how it would play out are unknowable. The point is, this is a very complex problem, and a wide array of factors including military capability will play a role in determining the ultimate outcome.I certainly don’t mean to predict such an apocalyptic outcome. All I’m really trying to say is that the military hegemony of the USA will almost certainly play into the equation. Even if there is no actual military conflict, the ability of the U.S. to defeat almost any opponent will play into the negotiations, if nothing else.

ConclusionsThe current incarnation of the International Monetary System, in which the USA enjoys the exorbitant privilege of borrowing practically for free, and is therefore able to pursue reckless fiscal policy with immunity from the adverse consequences that non-reserve currency issuing nations would experience by doing so, cannot continue indefinitely. Therefore, it will not continue indefinitely. How and when it will end is hard to say, especially considering the fact that it’s already persisted for 42 years after it stopped making sense. The system will continue to operate until some catalyst or trigger event brings about catastrophic change.The next Peak Cheap Oil price spike is not the only possible catalyst to bring about a U.S. bond and currency crisis, but it’s the most likely candidate I’m aware of. I don’t believe that U.S. energy independence is possible, but if it were, the end of oil imports from the Middle East would also be the catalyst to end exorbitant privilege and bring about a U.S.bond and currency crisis. To summarize, the music hasn’t stopped quite yet, but when it does, this will end very, very badly. I’m pretty sure we’re on the last song, but I don’t know how long it has left to play.

Great article easy to understand. Good that it recognises the most powerful military industrial complex does not have to take lying down losing world reserve currency status. That does not mean the govt is doing all it can to save everyones lifestyle, only its own continued existence and power. Just how valuable the average obsolete joe is to the state remains to be seen. Expansion of the proxy wars in syria and north africa look like the main vehicle.

A good article, all true, but it does frame in terms of nations, where things have gone a bit beyond that.

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The current incarnation of the International Monetary System, in which the USA enjoys the exorbitant privilege of borrowing practically for free, and is therefore able to pursue reckless fiscal policy with immunity from the adverse consequences that non-reserve currency issuing nations would experience by doing so, cannot continue indefinitely. Therefore, it will not continue indefinitely. How and when it will end is hard to say, especially considering the fact that it’s already persisted for 42 years after it stopped making sense.

Agreement with above, but it doesn't mention the trillions printed up by central banks for "bailouts", "loans" to other banks, and various discretionary spending. All of which is charged to the taxpayers of the nations and/or the holders of the currencies through inflation.

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The system will continue to operate until some catalyst or trigger event brings about catastrophic change.

Quite true. As UB pointed out, they are already busy cleaning up those in MENA who might want to resist the top tier solutions to the financial crises they will trigger when all is prepared. Always ready to "save" (rob) us in a crisis planned for that purpose. If a crisis develops before they are ready, they might have to go for some interim choice from tier B.

I would really like to see the contingency plans. I wonder if an annoying mouse could help

In the great battle of HI vs DF, it appears to me that with the Asset Confiscation ongoing in Cyprus, as well as Capital Controls being imposed all over the EZ (and in fact the world as the article below on the Ruskies from ZH shows), we have entered a New Phase where Money will be taken OUT of circulation, rather than new money being issued in Print to Cover.

The amount of Money Eurotrash can spend now on a daily basis is extremely restricted. Beyond that, plenty in Cyprus has already disappeared entirely from the economy.

Assuming the Euroclowns continue to follow this policy (and Diesel-BOOM's pronouncement this is a "template" indicates they will) there will be a massive collapse both in the Velocity of Money and in the Money Supply in the EZ. That doesn't mean the Euro will soar in value though, since anyone in their right mind is trying to unload Euros now. HI is not outta da question for the Euro here.

Far as the Dollar is concerned though, VERY Deflationary. Extreme scarcity of Dollars relative to a falling Euro will suck any liquid dollars outta circulation rapidly as Money Managers try to unload Euro based assets. Given the size of the Euro Banking Sector and the EXTREME Leverage, even on Overdrive I doubt Helicopter Ben could keep up.

There also is likely a Margin Call Event coming down the pipe from this in Europe. It will force Liquidation of Assets across the board, and the Eurotrash have a lot of Gold. I forsee a massive Collapse in the PMs market when the Euro Collapses. I think it is a 6 month-1 year timeline. Disclosure: I am going to short PMs and go LONG on the Dollar through this Shitstorm.

The Russians are taking a page from the Europeans book (and not a positive one for libertarians). Given the substantial criminal activity and illegal entrepreneurship in Russia - the grey and black economies account for 50–65 percent of GDP and estimates that about $50 billion was taken out of Russia illegally in 2012 alone - the great and glorious leaders have decided to impose restrictions on cash transactions. As Russia Beyond The Headlines reports, Russia may ban cash payments for purchases of more than 300,000 rubles (around $10,000) starting in 2015 - starting with a higher ($19,500) restriction in 2014. They will also enforce mandatory cash-free salary payments (cash compensation accounts for 15% of GDP currently) in an effort to both bring some of the population's 'grey' income out of the shadow; and increase the volume of cash reserves in the banks. It would appear that wherever we look now, leadership are realizing that the limits of fiscal and monetary policy have been reached and now changing rules, limiting freedom, and outright confiscation are the only way to maintain a status quo. Ironic really, when the enforcement of said rules may just be the catalyst for the end of the status quo as the middle class suffers.

Via Russia, Beyond The Headlines,

Russia may ban cash payments for purchases of more than 300,000 rubles (around $10,000) starting in 2015. The move is expected to boost banks’ cash reserves and put a damper on Russia’s shadow economy. However, the middle class will most likely end up having to pay the price for the scheme.

Moscow is looking to kill two birds with one stone: Firstly, it wants to bring some of the population’s “grey” income out of the shadow; secondly, it wants to increase the volume of cash reserves in the banks. The government’s bill will introduce the new rule to the State Duma. The document was prepared by the Ministry of Finance and approved by the government.

The restrictions on cash transactions will develop in two phases. In 2014, a ban on cash payments for purchases worth more than 600,000 rubles (about $19,500) will be introduced; the limit will then be halved to 300,000 rubles in 2015. Furthermore, the document introduces mandatory, cash-free, salary payments.

...

Even now, cash withdrawals on payday account for around 85 percent of all ATM transactions. Moreover, in 2005–2011, cash flows more than quadrupled. According to Bank of Russia estimates, more than 90 percent of all commodity purchases in Russia are paid for in cash.

The government is now trying to bring the shadow economy into the light and increase money flows into the treasury, according to Investcafe analyst Yekaterina Kondrashova. In her words, as soon as the new rules come into effect, those using unofficial wage payment schemes will encounter certain difficulties, although there could be some ways to circumvent the law.

The Ministry of Internal Affairs and the National Anticorruption Committee estimate the market for money laundering and cash conversions at somewhere between 3.5 and 7 trillion rubles ($113–230 billion) — about 60 percent of the Russian federal budget.

Rosstat reports that the volume of the shadow economy (“grey” money from tax evasion, compensations paid as “cash in envelopes” and violations of currency and foreign trade regulations) is at least 15 percent of the GDP, according to Ricom-Trust senior analyst Vladislav Zhukovsky.

Given the substantial criminal activity and illegal entrepreneurship, the grey and black economies account for 50–65 percent of GDP. Even former Central Bank Chief Sergey Ignatyev had to admit that about $50 billion was taken out of Russia illegally in 2012 alone.

There is another side to the move toward plastic, however. Cash-free payments will result in higher prices for some goods and services. The middle class will suffer the most, because the “risk group” includes property and automobile transactions. The luxury segment will also be affected, including customized tours.

I'm still in the deflation camp. Real life example: I get at least one paper thing stuck to my mailbox every week from some start-up lawn maintenance entity...and even though I'm tired of almost immediately throwing them into recycle bin, I look at the price they are offering. I have no interest in requesting their services, but for some reason I look at the offer. BTW, I have a "zoysia" lawngrass that is superior to it's sister grass "bermuda". I picked it to preserve water as zoysia is less water-dependent than bermuda. So for anyone out there with kids - this purchase was for you.

Back to my deflation preference - the amount of $$ requested for lawn maintence is steadily decreasing from my lens, at least for the last five years. But is this a reliable measure/metric for inflation/deflation?

Normally I would have dropped this piece by Ambrose into the AEP thread, but it is so over the top in the HI-DF category I hadda drop it here.

What is the gist of this? The Nips are going ALL IN to Inflate their dying Economy! As if Printing Yen will magically make them rich again. We can Recapitalize Ourselves! We'll Print More Yen!

Now you know of course Kuroda couldn't do this without a Full from Helicopter Ben. When Japan Inc. starts Pitching Out the Bonds, Da Fed will Buy Them. Why? Because NOBODY ELSE WILL, not even Mrs. Watanabe, who is FRESH OUT of Yen due to the Medical Bills she is paying for 2 Year Old Mariko Watanabe's Chemotherapy for Leukemia.

In reality of course, like here with Helicopter Ben pitching FRNs at his Goldman Buddies, Kuroda magically Printing Up Yen to LOAN to Nip TBTF Banks doesn't mean they'll loan it out to Hiromatsu Sushi Roll. Nor does it enable them to buy more Oil, even if Helicopter Ben keeps pace and Prints in tandem because...there is no more Oil to Buy! Printing more Money doesn't make new Cheap Oil fields and doesn't make Expensive ones Fracked Out any cheaper either. J6P here and HSR STILL can't afford the GAS to fill the Chevys and Toyotas!

Why would anyone Buy a Yen? What will a Yen buy you? Only the other CBs will buy Yen, to keep the Exchange Rate from going Ballistic. All that Printing won't do a damn thing to keep the Industrial Model running though. It's FINISHED.

The Bank of Japan has launched the most daring monetary experiment of modern times, aiming to double the money base within two years to overpower deflation and catapult the economy out of slump.

By Ambrose Evans-Pritchard8:09PM BST 04 Apr 2013118 Comments The blast of money is expected to reignite the yen “carry trade” and flood global markets with up to $2 trillion (£1.3 trillion) of pent-up savings, giving the entire world a shot in the arm.

The BoJ’s new team under governor Haruhiko Kuroda voted 8:1 for a double dose of “quantitative and qualitative monetary easing”, vowing to inject stimulus for “as long as it takes” to break the deflation psychology.

“This will be recorded in economic history books as a watershed in central bank action. Investors should be shocked and awed,” said Stephen Jen from SLJ Macro Partners.

The monetary base will rocket from 29pc to 56pc of GDP by 2014. The pace of bond purchases will rise to 7.5 trillion yen (£53bn) a month, almost three times the US Federal Reserve’s stimulus as a share of the economy. The maturities will stretch to 40 years, ending the three-year cap that has hobbled policy for a decade.

“This is a huge sum. It could set off a rip-roaring economic boom if they buy the bonds from insurance companies and boost broad money by 10pc over the next year,” said Tim Congdon from International Monetary Research.

Mr Kuroda said the bank had taken “all available steps” to meet its new target of 2pc inflation within two years. “This is an unprecedented degree of monetary easing,” he said.

The scale of action caught markets off guard, sending 10-year bond yields tumbling to an all-time low of 0.44pc. The yen weakened three “big numbers” to 96 yen against the dollar, in the biggest one-day move for more than a year. The Nikkei index of stocks jumped 2.2pc, crowning a 50pc rise since October.

Hans Redeker, from Morgan Stanley, said the package was dramatic enough to break “Endaka” – strong yen – once and for all. “The carry trade is going into full swing. Japan’s institutional funds are going to wind down their currency hedges from 70pc to a normal hedge ratio nearer 35pc, and that will free up $1 trillion of overseas lending,” he said.

“This is a gigantic fixed-income machine. They don’t buy equities and real estate. They buy bonds, and we think they’ll look at peripheral eurozone markets like Italy and Spain.”

Japan’s legendary housewives and grannies – so-called “Mrs Watanabe” – lead a phalanx of retail investors with another trillion dollars waiting to venture abroad once again in search of yield. In the 2003-08 cycle, the money leaked into everything from Australian “Uridashi” bonds and Icelandic debt, to London property.

Simon Derrick, from BNY Mellon, said Japan’s battle-weary investors may be more cautious this time, chilled by North Korean jitters and tensions with China. “We don’t think the climate is yet right for the carry trade,” he said.

Hiroaki Muto, from Sumitomo Mitsui, said the Kuroda experiment could go badly wrong if markets started to think the BoJ was printing money to cover Japan’s fiscal deficits. “At some point, yields could spike”, he said.

Japan is the only major country yet to start retrenchment. Premier Shinzo Abe is boosting spending by an extra 2pc of GDP to kickstart recovery, though the budget deficit is already 9pc.

Japan has had no trouble raising funds from its captive debt markets so far, but ageing costs are rising and public debt will reach 245pc of GDP this year.

The International Monetary Fund says Japan may hit the buffers unless it changes course soon, warning that confidence can evaporate fast. A 200 basis point rise in borrowing costs would play havoc with public finances.

Mr Kuroda played down the concerns, insisting there was no risk of a “sudden” jump in long-term rates or a fresh asset price bubble.

Japanese officials say monetary stimulus should protect against a debt compound trap by cutting “real” rates. While Japan’s borrowing costs look low, they are higher than in the US, Britain or Germany if adjusted for deflation.

The Kuroda policy is radically different from past episodes of BoJ stimulus, mostly half-hearted tinkering to fend off political pressure. It brings the BoJ into line with the US, UK and Swiss central banks.

The European Central Bank looks increasingly isolated after it sat on its hands on Thursday, offering little to soften the credit crunch in Italy and Spain. The hawkish stance is leading to an over-valued euro. “We’re afraid that the euro could rise further. That is the last thing that Europe needs,” said Mr Redeker.

The euro has risen 32pc against the yen since July, giving Japanese exporters an edge over European rivals. A Ford executive warned last month that Japanese car makers are poised to sweep the EU market.

An army of doubters question whether Mr Kuroda’s shock therapy will feed through to the real economy. Daragh Maher, from HSBC, fears a “damp squib” outcome that exposes the limits of central banking, or a “UK replay” where inflation rises but wages lag, causing a squeeze in real incomes. “Neither would point to a new era for Japan’s economy.”

I'd hate to say it but this time really is different. Never before has there been coordinated global money printing of the scale of today. Ever. Japan intends to double its money in circulation in just two years. This is incredible stuff. But it only mimics the U.S. Federal Reserve which has tripled the amount of dollars in circulation since 2008. Most stock brokers and mainstream media will tell you that this money printing is what's needed to stimulate economies and whether it succeeds or not, the outcome will be relatively benign. Don't believe them. It's highly likely that this is not a normal economic cycle and the consequences will be more extreme: success will mean all the printed money filters through to economies resulting in double digit inflation or failure will bring serious deflation. In other words, the most probable outcomes aren't pretty and you need to prepare your investment portfolios as such. Today I'll suggest some ways that you might be able to do this. Sayonara to JapanFirst to Japan. You've got to love mainstream media, investors and stockbrokers. The Japanese central bank's plans to end deflation have been widely greeted as having surpassed expectations. They're described as "bold", "inventive" and just what Japan needs after sitting on its hands for 20 years. Nowhere have I seen words such as "stupid", "insane" or "half-witted". Because anyone with a brain can tell you that Japan's plans will have terrible consequences, whether they succeed or not. First, let's look at what Japan intends to do:

It will double current stimulus to 7.5 trillion yen (US$81 billion) per month. This means buying the equivalent of 70% of the total long-term government bonds in markets.

It will buy Japanese government bonds with maturities of up to 40 years, seeking to push the average duration of Bank of Japan (BoJ) bondholdings to seven years, from the current three years.

It will increase purchases of financial instruments linked to the stock and property markets to lift the prices in those sectors and encourage other investors to buy them. More specifically, the BoJ will increase purchases of exchange traded funds (ETFs) by 1 trillion yen per year and real-estate trust funds (REITs) by 30 billion yen per year.

The BoJ put a timeline of two years on its prior promise to achieve 2% inflation. To put this into some context, Japan's stimulus of US$81 billion a month compares to the U.S.' own US$85 billion program. But Japan's economy is much smaller than the U.S.. Adjusted for GDP, Japan's stimulus will be twice as large as America's. It makes Bernanke look like a patsy.Now I'm not going to detail the reasons why the BoJ package will be a disaster for Japan, as I've done it previously [COLOR=#NaNNaNNaN]here[/COLOR], [COLOR=#NaNNaNNaN]here[/COLOR] and [COLOR=#NaNNaNNaN]here[/COLOR]. Suffice to say, if Japan succeeds with its 2% inflation target, interest rates will rise at some point and they just need to reach 2.8% for the interest on government debt to equal government revenues (currently, interest of government debt takes up 25% of government revenue). The bond market will revolt well before it reaches that point though.[/SIZE][/FONT]If Japan fails in its bid to increase inflation, you'll see government debt balloon. Japan's current government debt to GDP is 245%, by far the highest of any country. The debt is also 20x government revenues. Bondholders aren't going to sit there earning less than 0.6% on Japanese government bonds while debt increases and the yen tanks. And to reiterate a point that I've made previously, those that assume the Japanese government bond market can never blow up as domestic Japanese own 91% of the market are looking through the rear-view mirror. Ageing Japanese need to fund their retirements and won't be able to support the government bond market as they've done in the past. Foreign investor holdings of government bonds is 9% and rising. They're going to be want better returns for the risks that they're taking on.I'm on the record suggesting that I don't think the BoJ plans to lift inflation will work. Whether right or wrong, it seems inevitable that the yen will significantly depreciate from here. And that the bond market will crack at some point, though putting a date on that is very difficult given extreme government intervention in the market.Others will follow suitJapan is likely to prove a prelude of what's to come in much of the developed world. The West, like Japan, has way too much debt and economies haven't been restructured to make them competitive again. And the West is falling into the same trap as Japan by trying to inflated its way of over-indebtedness. You can be certain of more desperate measures from western central banks as they try to stave off a Japanese-style deflationary slump. Investing in this type of environment will be tricky, to say the least.Take the U.S. for example. Many of the country's cheerleaders suggest that the economy is recovering, led by the housing sector. What they don't tell you is that GDP growth of 2.2% in 2012 is still way below the 3.2% average since World War Two. Nor do they emphasise the still very high unemployment rate, above 11% if you include people that have dropped out of the workforce since 2008. More importantly, all the evidence suggests deflationary forces - principally households intent on paying down debt - are beating the Federal Reserve's (Fed) best efforts to lift inflation. The velocity of money is one of the best indicators that deflation is getting the better of the Fed. Since the financial crisis, the Fed has flooded the economy with printed money, trebling the so-called monetary base. That base consists of highly liquid money, such as coins, paper money and commercial bank reserves with the central banks. Under normal circumstances, increasing the monetary base to this extent would be highly inflationary. But the problem is that this money is not making its way into the economy or changing hands (money velocity). That's why money velocity in the U.S. has dropped to a more than 60-year low. Rising money velocity indicates that the same quantity of money is being used for several transactions. It's turning over, signalling a robust economy. Declining velocity, on the other hand, indicates money isn't changing hands and that the economy is anything but healthy. What declining velocity of money suggests is that banks are sitting on excess money because households aren't willing to borrow as they're busy paying down debt. Meanwhile businesses, which are less indebted, aren't confident enough in the economy to borrow money and invest it.If you're thinking that Japanese businesses and households may have exhibited similar behaviour over the past 20 years, you'd be right. That's why Japan also has money velocity reaching multi-decade lows. Declining money velocity is one of several signs that the Fed is failing in its battle to produce inflation in order to revive the U.S. economy and reduce the country's debt. The larger point is that as long as this remains the case, Bernanke will continue with stimulus. And if stimulus continues to fail, he (or whichever like-minded academic takes over from him) will get more desperate and use unconventional methods like Japan is now (such as buying stocks directly, for instance).How do investors position themselves?The question then becomes: how do you allocate your assets given this atypical economic environment? In investing, no bet is a sure thing. But what you can do is look at the facts, the probable outcomes and invest where the odds are in your favour.So let's take a look at the probable outcomes. I see four possibilities:1) Mild inflation and a global economic recovery. This is the outcome that stock markets are currently betting on. If it happens, stock would be the place to park your money, while bonds, precious metals and cash wouldn't be.

2) Inflation does lift off but central banks tighten policy early, resulting in economic contraction, and likely recession. Stocks would initially benefit then suffer. Bonds would initially perform poorly, then outperform. Precious metals would rise with inflation, then probably fall as contraction takes place. This outcome appears unlikely though as central banks will be loath to switch off stimulus early. Ben Bernanke is obsessed with the Great Depression, when stimulus was stopped too soon before recovery could happen, in his view.3) A global economic recovery happens but inflation gets out of hand as all the printed money flows through to economies and central banks seem powerless to stop it. In this instance, stocks, bonds and cash would get punished. Precious metals would benefit most.4) A more serious deflationary depression happens. Stimulus fails and debt compounds until the weight of it kills economies. Under this scenario, long-term bonds would outperform, though low current yields make substantial outperformance unlikely. Cash could outperform if you're in the right currencies. Precious metals may also outperform if confidence in currencies dissipates. You wouldn't want to own stocks if a deflationary depression occurs.

As you may have gathered, I think the most probable outcomes are 3) and 4) with 4) being the most likely. Precious metals should outperform under both scenarios 3) and 4) and therefore overweighting this asset class makes sense. Holding some cash also makes some sense, though it could suffer under serious inflation. Long-term government bonds may be worth holding, though currently at almost all-time low yields, upside appears very limited. Meanwhile, you'd want to stay almost entirely out of stocks if scenarios 3) and 4) turn into reality. Channelling Harry BrowneHow you invest your money will obviously depend on your own circumstances, including which country that you're located in. Some of you may feel uncomfortable holding large quantities of precious metals or staying out of stock altogether. This is understandable.If that's the case, I'd guide you towards a safe, easy-to-follow investment portfolio that's likely to perform under any of the probable outcomes mentioned above. The portfolio was first advocated by the late [COLOR=#NaNNaNNaN]Harry Browne[/COLOR]. [/SIZE][/FONT]Browne was an American investment newsletter writer who wrote numerous books and found fame after writing the 1970 bestseller, How You Can Profit From The Coming Devaluation. That book accurately forecast the 1970s slump and the need to be substantially overweight precious metals, particularly silver. He went on to run as a Libertarian Party candidate for the U.S. Presidency in 1996 and 2000.Later in his career, Browne advocated what he called a bulletproof portfolio, which could perform under any economic environment. This portfolio turned into the [COLOR=#NaNNaNNaN]Permanent Portfolio[/COLOR], a mutual fund that's now listed in the U.S..[/SIZE][/FONT]Browne's original idea, outlined in his book Fail-Safe Investing, was that a safe, easy-to-follow investment portfolio should consist of 25% in long-term government bonds, 25% in cash (money market funds), 25% in stocks (growth style mutual funds) and 25% in gold.His thesis was that each of these assets would outperform during one or more economic environments, whether it be prosperity, serious inflation, recession or depression. And this outperformance would outweigh the underperformance of some of the other assets during particular periods. For instance, gold's outperformance during the 1970s inflationary period more than offset the underperformance of stocks, bonds and cash. Browne surmised that such a portfolio would deliver good long-term returns with limited volatility. He's been proven right as the Permanent Portfolio has done just that, outperforming the vast majority of mutual funds in the U.S. with very few down years. Note that the listed fund has deviated somewhat from Browne's original proposed allocation, though not by a lot.Now I'm not advocating that you necessarily go out and invest directly in the Permanent Portfolio fund as it depends on your particular needs and circumstances. However I am suggesting that Browne's ideas may be worth considering as a potential guide to navigating the uncertain economic environment ahead. Interestingly, investment guru Marc Faber has proposed a remarkably similar investment portfolio to that of Harry Browne, the only difference being that instead of owning long-term government bonds, he suggests real estate instead (he thinks inflation is on the way and is a well-known bear on long-term U.S. government bonds).

Submitted by Tyler Durden on 04/08/2013 00:21 -0400Following Friday's epic collapse, snap-back, and circuit-breaker halt in JGB Futures, it appears that investors cannot get enough of Japanese bonds today. From the JPY144.02 close, JGB Futures traded up at the open, oscillated and then gapped higher (on heavy volume) to JPY145.25 before the TSE halted trading once again (on a volatility-based circuit-breaker limit) due to 'rapid price fluctuations. The quadrillion JPY cash JGB market appears very illiquid as we scan the benchmark issues with the 30Y yield higher by 4bps, the 20Y lower by 14bps, and the 10Y lower by 3bps as it appears the futures are the weapon of choice. Since the halt ended, JGB Futures have slipped back notably. It seems pretty evident when and where the BoJ monetization took place but desk chatter was that it was poorly run.

but in contrast to Friday's epic fail this brief surge in price appears nothing...

This should give some more context for just how broken these markets are. A 5bps drop in a 50bps 10Y yield (the BoJ monetization?) followed by a 7bps rip higher!! Interesting that JPY was sold hard during the break in Cash bond trading...So absent the BoJ's efforts today, the JGB market would have been significantly uglier.

There also is likely a Margin Call Event coming down the pipe from this in Europe. It will force Liquidation of Assets across the board, and the Eurotrash have a lot of Gold. I forsee a massive Collapse in the PMs market when the Euro Collapses. I think it is a 6 month-1 year timeline. Disclosure: I am going to short PMs and go LONG on the Dollar through this Shitstorm.

Gold closed down below $1500 and I closed out for now on the shorts. I think it still has a ways to go but won't be linear, short squeeze coming soon.